Washington Tackles Target-Date Reform

While the rest of the world focuses on the Obama administration’s sweeping regulatory reform package, another corner of Washington is tackling a $489 billion problem of its own: target-date funds. The premixed fund-of-funds, which are supposed to get more conservative as investors near retirement, have become one of the most popular retirement investments of the last decade; they also suffered severe losses during the crash, even for investors hoping to retire in a year or two. Now, at the request of Sen. Herb Kohl (D., Wis.), the Department of Labor and the Securities and Exchange Commission will convene an all-day hearing to discuss what, if anything, should be done about the funds — and which regulatory agency is ultimately in charge.

In fact, by holding the hearing jointly, the agencies are acknowledging that target-date funds have become messy for the regulators. The SEC regulates mutual fund companies and mutual funds, but the DOL is in charge of retirement plans. When the Pension Protection Act allowed employers to automatically enroll employees in the retirement plan as long as they picked an investment for them, too, the DOL blessed target-date funds as an acceptable default option. Then funds for workers hoping to retire in 2010 lost as much as 40% in 2008; the DOL is now, apparently, rethinking the wisdom of conferring special status on target-date funds.

The DOL has plenty of options, investor advocates say, if it’s serious about protecting participants. It could impose restrictions on what a target-date fund is — that is, if a 2010 fund wants to qualify as an acceptable default, it must adhere to “a generally accepted allocation,” suggested Mercer Bullard, president of Fund Democracy, a shareholder advocacy group. He suggested the DOL create an advisory board that would establish and review that generally acceptable standard. “But everyone knows that 75% equities is not generally acceptable for someone who is 65,” he said. “Is it acceptable for some people? Yes. But generally? No. And that should be the threshold when employers are making choices for their employees.”

But the fund industry says that disclosure and education should be enough; then it’s up to the employer to decide what’s appropriate. The stakes are high: Assets in target-date funds in 401(k) plans have more than doubled since 2005, even after 2008’s losses. Any restriction on which target-date funds could qualify would also restrict that flow of cash. Managers, of course, take the free-market high road. “Any approach that would narrow the flexibility of managers might hamper our ability to manage lifecycle funds for our clients,” said Jeff Coons, the co-director of research at Manning and Napier, which launched retail target-date funds last year.

Of course, it’s not all up to the DOL. The SEC could invoke its “misleading names” rule, which requires funds to invest in a way that’s consistent with their names — a large-cap growth fund must, for the most part, buy large-company stocks. Mary Schapiro, the head of the agency, has indicated that her organization would consider it (a reversal of earlier statements), but it would be a stretch: The rule has never applied to asset allocation in the past.

No decisions will be made at Thursday’s hearing, and skeptics worry that any momentum for reform will be overshadowed by the Obama announcement. Even so, over more than eight hours, 33 representatives of fund managers, financial planners, industry associations and investor advocates will offer their opinions on everything from asset allocation to the 401(k) plan marketplace. As to the question of which agency will ultimately take the reins, the early money is on the DOL. Not only has the SEC been notoriously reluctant to constrain fund managers, but the hearings are in the DOL’s house.